The Master Budget, Return on Investment, and Financial Resources Allocation in Capital Budgeting
The two selected techniques/concepts that interest me within the specified chapters are;
- The master budget
- Return on investment
One of the primary focus of capital budgeting decisions is the strategic allocation of financial resources within the organization. There are various tools and techniques that organizations can utilize to attain this objective. One of the most relevant concepts in this sense is capital budgets. As elaborated in chapter 10 of the text by Blocher, Stout, & Cokins (2016), the master budget is a key planning tool that management accountants can utilize to coordinate operations and provide financial targets to guide managerial decision-making. Resource allocation is an essential element of the strategic management process and budgets are vital to carrying out these goals by ensuring that effective strategies and decisions have been made concerning the allocation of strategic resources (Maritan, & Lee, 2017).
As a sum of the total budget for the company, the master budget helps the organization in forecasting future expenses thereby facilitating the process of fund allocation to the different departments or areas so as to effectively meet the forecasted expense. In addition, the master budget also acts as a control tool as it helps in the evaluation of past performances, as well as the assessment of future performance, hence providing guidance on the areas to invest in. Besides, by indicating the level of resources that should be committed to particular programs or departments, the master budget sets allocation limits that will ensure the capital budgeting process will not result in financial shortfalls.
Another important concept when it comes to capital budgeting decisions and resource allocation is the return on investment (ROI). In Chapter 19 of the text, the authors point out that the ROI is the most commonly used measure of the short-term performance of a particular investment (Blocher, Stout, & Cokins, 2016). It is a performance measure that evaluates the efficiency of particular investments and compares it with the efficiencies of other investments so as to determine which investment offers the best alternative for the organization. As Issar and Navon (2016) pointed out, the return on investment is an important tool that helps organizations to plan annual operational budgets and compare between different alternatives for investment.
The limited nature of financial resources within organizations means that one of the most important capital budgeting goals is to ensure that adequate resources have been allocated to viable projects that will provide the most benefits to the organization. The allocation of assets and resources should take into account the predictable returns for the investment (Chen, Jiang, & Tu, 2014). The return on investment, therefore, facilitates proper financial allocation in capital budgeting by predicting investment returns, and in so doing sort the available projects and programs on which have the highest probability of investment. Managers can then go ahead and utilize such information to make sure that projects and areas with higher rates of returns have been given priority when allocating limited financial resources.
Blocher, E. J., Stout, E. D., & Cokins, G. (2016). Cost management: A strategic emphasis. New York McGraw-Hill Education
Chen, J., Jiang, F., & Tu, J. (2014). Asset Allocation in Chinese Stock Market: The Role of Return Predictability. Journal of Portfolio Management, 41(5) 71-83. https://ssrn.com/abstract=2774692
Issar, G., & Navon, L. R. (2016). Return on Investment (ROI) Calculations and CAPEX Decisions. Operational Excellence, 4(5). 129-130. DOI https://doi.org/10.1007/978-3-319-20699-8_28
Maritan, A, C., & Lee, G. K. (2017). Resource Allocation and Strategy. Journal of Management, 43(8), 2411–2420. https://doi.org/10.1177/0149206317729738